Have extra money? Should you invest or pay off debt? Here's how to decide
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An unexpected windfall. A long-awaited bonus at work. Or a surprise inheritance.
All of these events have one thing in common. They make you happy. That, and they bring in some extra money. Naturally, it may be tempting to spend the extra cash on something you've always wanted. Like a trip to the new fine-dining restaurant in town. Or a quick weekend getaway. Or even simply that premium gadget you've been eyeing for a while.
But these dispensable expenses aside, there are smarter ways to use that extra money. Like investing those funds. Or using them to pay off your debt.
Both of these are worthy goals. So, how do you decide between investing your surplus cash or paying off a debt? Let's find out.
Investing vs. paying off debt
Investing is all about taking care of your future. By buying assets like stocks, bonds, real estate, gold or mutual funds, you can benefit from any increase in their value over the long term. The gains from these investments can help you meet your major life goals.
Repaying your debt, on the other hand, involves paying back money that you have already spent. This is money that you have borrowed from a lender, and you need to pay it back along with the interest charged on the basic amount borrowed. The longer you take to repay it, the more the interest accumulated.
As you can see, both investing and debt repayment are financially essential. And they each come with their own benefits.
The upsides of using surplus cash to invest
Using the surplus cash to invest comes with several obvious benefits. Here is a closer look at the top reasons to choose investing.
Longer time for your money to grow
Putting off investing can rob you of precious time. By starting your investment journey earlier, you give your money more time to grow. Naturally, you will be able to accumulate a bigger corpus over the long term. In fact, investing earlier in life, even if you invest smaller amounts, can pay off more than investing larger sums later in life.
For example, if you invest Rs. 5,000 each month for 20 years, at the rate of 12% per annum, you will accumulate a corpus of Rs. 49.95 lakhs. However, if you put off your investments by 5 years and increase your monthly investment amount to Rs. 7,000 instead, you will only accumulate around Rs. 35 lakhs at the end of 15 years.
Securing your future life goals
Investing also helps you secure your future life goals. You're better prepared for all the big milestones in life, because you would have planned for them early on and invested accordingly. Without having a reliable investment portfolio to fall back on, you may have to resort to more loans to fulfill your life goals.
The upsides of using surplus cash to pay off debt
Repaying your debts with any extra cash you come by is also a good idea for various reasons. Check out the key benefits of opting for this course of action.
Improvement in your credit score
Paying your debts promptly has a positive impact on your credit score. This number is very crucial if you want to avail a loan in the future. A good credit score comes with many advantages like easier loan availability, more affordable interest rates and a higher loan amount.
Peace of mind
A high amount of debt can disturb your peace of mind. And for some people more than others, debts can be psychologically stressful. So, if you find yourself losing sleep over the mounting interest on your debt, it may be a smart idea to use extra funds to repay part or all of your debt.
A cost-benefit analysis can help you decide
If you are still unable to decide which of the two may be the right course of action for you, why not do a quick cost-benefit analysis. For this, you need to consider the following two rates.
- The rate of return you could earn on the investment of your choice
- The rate of interest on your debts
If the rate of return you could earn by investing exceeds the rate of interest on your debts, you could choose to invest your money and use a part of the returns to pay off your debts.
For example, say you wish to invest in an index fund that gives returns of around 12% per annum. And you have a housing loan that carries an annual interest rate of 7.5%. In this case, you could invest in the index funds since it offers higher returns than your loan interest rate.
On the other hand, if you have high-interest debt like credit card dues that carry an interest rate of 40% per annum, it makes more financial sense to repay this high interest debt with any surplus funds before you focus on investing.
Investing and debt repayment: Is it possible to do both?
Interestingly, it does not always have to be a choice between the two. It is possible to repay your debts and invest your extra funds simultaneously. One way to do this is to redirect a part of the surplus cash to your debt repayment efforts, and invest the rest of the money in your emergency fund.
This way, you are better prepared for any unexpected eventualities in your immediate future, and at the same time, you also clear a part of your debt.
The choice between investing and debt repayment may be more precise for some people than for others. So, ultimately, the answer to which of these is the right option depends entirely on your financial situation, your life goals, and the nature and amount of your debts. If you are still unable to make a clear decision between the two, you could always take the help of a financial advisor.
Read next: ARE YOU READY FOR DIFFERENT LIFE GOALS?
Paying off debt is just one of the many life goals you may have. There are other milestones too, like buying your first home, taking an extended vacation with your family, and saving up for your children's higher education. Are you financially ready for these life goals? Our blog can help you answer this question.
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